"Cumulative Impact of Fees..."

[Dicast]

I was browsing bogleheads the other day and someone posted an old Vanguard blog post.  I have found it pretty useful when discussing the overall effect of fees with people that keep saying "It is only 1%, what's the big deal?"  I copied it below for ease of use.  I've bookmarked it to my phone because people "know" I'm interested in investment stuff.

Cumulative impact of fees on ending wealth at various time horizons

	Annual Fee Rate
Time Horizon	0.10%	0.25%	0.50%	1.00%	2.00%	3.00%
3 years	–0.3%	–0.7%	–1.5%	–2.9%	–5.8%	–8.5%
5 years	–0.5%	–1.2%	–2.5%	–4.9%	–9.4%	–13.7%
10 years	–1.0%	–2.5%	–4.9%	–9.5%	–18.0%	–25.6%
20 years	–2.0%	–4.9%	–9.5%	–18.0%	–32.7%	–44.6%
30 years	–3.0%	–7.2%	–13.9%	–25.8%	–44.8%	–58.8%
40 years	–3.9%	–9.5%	–18.1%	–32.8%	–54.7%	–69.3%

[jfoxcpacfp]

I realize that AUM is not popular on this site and that the Fixed Fee model has been put forth multiple times as an acceptable alternative. (For that reason, I have added a FF model to our options.) However, do you realize that this concern can be addressed by simply paying AUM fees outside the portfolio? i.e. many of our clients opt to mail us a check.

Sure, it costs money to hire a financial planner, but it is not necessarily a drag on the portfolio. If portfolio drag is a concern, simply pay outside the portfolio, whether AUM or Fixed Fee or by another calculation. Then you compare apples to apples and frame the issue properly: Is the value of the service worth what you are paying for it?

[Dicast]

The assumption that there is no portfolio drag if you pay your AUM fees from outside of the account is another type of "thought process" where a person may fail to consider the whole portfolio.  Any money that is used for fees is money that is not available for investing and wealth accumulation.  I don't know up front whether it is better to pay fees from a tax deferred portfolio or if it is better to pay them with after-tax "other money", but it doesn't matter if the comparison is not paying the fees.  (As a general rule, I do not leave "extra" money sitting in my accounts.  I have a set emergency fund and after monthly expenses anything above that number is removed to pay down loans/invest.  Any longer term expenses such as house downpayment, car purchase or planned trip are funded into a discover bank high yield account.)

Further, the combination of fees from both a financial planner and the mutual funds they may put you in can be significant.  Take the standard 1% AUM and add a not so crazy sounding 0.5% ER and give it 20 years.  The cumulative impact will be >20% of ending wealth.  Knock it down to 0.5% AUM and invest in low cost Vanguard index funds and the total is still going to be over 10% of total wealth at 20 years.  For myself, planning to retire with somewhere around 5 million in retirement funds, I think this is an extremely important topic.  It could mean extra years of work or retiring with less money than my goal.

I don't disagree that some investors would be much better off with a financial planner, maybe even at 1% than trying to do some of this themselves.  I had a partner tell me about his Porsche this week.  We are the same time frame out from residency.  He is single, presumably fewer expenses.  I have a family...so I asked.  "You've already knocked out your loans right?"  Response..."I'll get to it later".  Next question "You max your retirement right?" Response..."I do and I try to get some extra by buying individual stocks."  He uses technical analysis to make his stock picking decisions.  I think he could probably use a financial planner.

 

[The White Coat Investor]

Yes, paying them from outside doesn't reduce the drag. Those payments are the equivalent of contributions to the account. In fact, it's probably worse because you can probably pay fees from inside the portfolio with pre-tax money.

Fees matter. Doesn't mean you don't get value for them, but it's important to pay attention to the cost and compare it to the value.

[PhysicianOnFIRE]

I've taken a detailed look at how investment fees can cost millions. A solid DIY plan that follows a sound IPS is the least expensive and can be the way to go for someone who has the time and inclination to want to do it and knows how to do it right. That is probably a fairly small percentage of physicians (who are overrepresented on this forum, though). The worst way to manage your money is to DIY without a plan or decent understanding personal finance and investing.

In between the best and worst are plans that involve fees, which are going to be appropriate for the majority of investors. Know the advisor's fees, fiduciary responsibity, and their value to you.

[jfoxcpacfp]

The White Coat Investor wrote:

Those payments are the equivalent of contributions to the account. In fact, it’s probably worse because you can probably pay fees from inside the portfolio with pre-tax money.

Click to expand...

That's like saying that buying a new motorcycle is the equivalent of contributions to the account.

I'm not saying that people spend a lot on advice that isn't worth the price - you're preaching to the choir. I am saying that focusing so much on the drag on the portfolio confuses the issue. It distracts from the contention that most financial advice costs more than the value received. I just don't recall seeing portfolio drag used to argue against fixed cost advisor models, even though it has the same effect using the above logic.

[The White Coat Investor]

I agree, same effect with a fixed fee advisor. But over the years that fixed fee becomes a smaller and smaller percentage of the AUM.

[Docbeans]

The only benefit to paying fees with "outside the portfolio" money is for self-employed folks who can take a 100% tax-deduction on all fees paid for business-related retirement plans (401k,SEP etc).

[BullBear]

I am considering going to a firm for fee-based AUM guidance.  I am currently dragging along at a 7% interest rate, and have been very open with them that for them to keep my business, they will need to match/outperform my current return.  While I spend a large amount of time researching investments, and tweaking my portfolio, I am wondering if leaving the rebalancing to them, combined with their addition of new investment vehicles will outperform my steady rate.

My questions are twofold:

1) Is is reasonable to only pay fees for AUM that make an annual profit?

2) if I earn 7% on  my own, they earn 8% then charge a 1% fee, is the net 7% return worth the cost of them doing the hard work and letting me focus on other areas of my life outside of my portfolio?

 

Also, before I make any decision, I will ask them to run a regression analysis of any portfolio changes they propose, and demonstrate to me that my net, after their fees and taxes, their return over the last three years would have exceeded mine.

Is this a good strategy?

[jfoxcpacfp]

BullBear wrote:

My questions are twofold: 1) Is is reasonable to only pay fees for AUM that make an annual profit?

Click to expand...

If you are looking for "fee-based", you are not protected from commissions. You want to hire a fee-only firm.

BullBear wrote:

2) if I earn 7% on  my own, they earn 8% then charge a 1% fee, is the net 7% return worth the cost of them doing the hard work and letting me focus on other areas of my life outside of my portfolio?

Click to expand...

Up to you. Constructing and managing a portfolio is not rocket science, although you seem determined to make it difficult. The hard work is in preparing and monitoring the financial plan upon which the portfolio is built and managed to serve.

BullBear wrote:

Also, before I make any decision, I will ask them to run a regression analysis of any portfolio changes they propose, and demonstrate to me that my net, after their fees and taxes, their return over the last three years would have exceeded mine. Is this a good strategy?

Click to expand...

Not to me, but I bet they will fall all over themselves to do it.

With all due respect, I would not consider you for a client. But that is because you are looking for an investment manager and I am a fee-only financial planner who employs investments as a means to an end, not the end itself. Just not a good fit. Perhaps Kon will chime in. And, seriously, you're probably better sticking with the 7%, regardless of the time you spend "tweaking". The real test will come in the next bear market, of course.